What Are Custodial Fees?
Understanding the Costs of Portfolio Management
At some point in your investing journey, you'll likely encounter custodial fees, sometimes referred to as safekeeping fees. These terms can mean different things depending upon the context of your investment portfolio.
Specific types of custodial banks, often called custodians, safeguard securities for individuals or companies. These entities do not engage in typical commercial or retail banking; they focus on holding various assets for safekeeping. This includes stocks, commodities, bonds, currency, and precious metals. These types of companies also facilitate certain types of transactions, such as foreign exchange, arranging settlements for security or currency purchases or sales, and administering different actions related to securities, including stock splits, bond calls, stock dividends, and business mergers.
The Chain of Ownership
If a person living in the United States owns securities but is not a member of a stock exchange, they own the securities through a chain of registration typically involving one or more custodians. The process works this way because it would be impractical to register traded shares or other securities in each individual holder's name. Rather, the custodian is registered as a holder of the security and keeps them in an arrangement with a fiduciary responsibility to the actual owners.
In a custodial relationship, the person that purchased the asset always remains the legal owner.
When you invest in stocks, bonds, mutual funds, or otherwise become an owner of a security, the executing broker takes cash out of an account and pays the person or institution from whom you are making the acquisitions. Once it receives the security, it stores it for you. Unless you request a physical stock certificate or insist upon the use of the direct registration system, you will typically have the securities placed in a global custody account of some sort.
The custodian keeps the assets safe, collects your dividend and interest income for you, gives you a monthly or quarterly account statement, handles any corporate actions such as receiving shares of a spin-off or making an election for cash or stock following a merger. It also performs a host of other housekeeping tasks that would become overwhelming and quickly out of date if you had to deal with the duties personally.
Custodial fees refer to any fees a qualified financial custodian, such as a bank trust department or registered broker-dealer, charges you for its custodial services.
This term has become rarer but it usually, though not always, refers to a service, particularly by bank trust departments, for handling custody on behalf of a client who wants to keep their physical stock certificates on hand at the bank; usually in their name rather than a street name. (A street name is the name of the bank, dealer, or brokerage firm that holds the stock or other securities on behalf of the owner.)
When a security or asset is placed in safekeeping, the investor or depositor receives a receipt proving ownership. The asset does not become the property of the institution, so even if it went bankrupt, its creditors couldn't go after the securities—they would be returned to their rightful owner.
If the investor places a sell order, the bank trust department or custodian would physically hand over the stock certificate to the broker prior to the settlement date. The custodian would also add additional certificates received from spin-offs to the vault, making sure the investor received their entitled share.
The Cost of Custodial Fees
Fees vary quite a bit depending on the firm you are working with and the services it offers.
Many investors place their assets in the custody of their broker in a brokerage account, a convenient option handled so seamlessly that many people don't even realize they serve a different function. Unless special treatment is requested, these securities will almost always be held in a street name.
Brokerage firms do this to attract as many investors as they can in the hopes of generating trading commission revenue. As a result, many firms waive custody fees entirely. You may not even realize you're paying them because the costs are rolled into the commissions on trade executions.
It isn't unusual for some firms to charge minimum annual fees if you don't have a certain amount of money in your account or you don't engage in any trades for a certain length of time to help it offset the expense of servicing the account. For example, look at a trading platform such as Interactive Brokers. If a customer of the firm has less than $100,000 in an account that generates less than $10 in trading commissions per month, a makeup fee of the differential is applied so that each account pays at least $120 per year to cover Interactive Brokers' costs, including custodial fees.
This is necessary because Interactive Brokers focuses on large, significantly wealthier clients who want economies of scale. Customers are allowed to choose between a fixed-rate fee schedule and a tiered fee schedule. On the tiered schedule, the commission is $0.0035 per share for U.S. stocks with a maximum commission rate of 0.5% of the trade value.
If you bought 1,000 shares of The Hershey Company as of May 1, 2020, at $93.49 per share for a total of $93,490, you'd pay Interactive Brokers a commission of $3.50, or 0.0037%, as well as some nominal exchange fees, clearing fees, and other fees which are equally minor. You either have to be a sufficiently large account or generate some trading revenue for it to justify keeping your assets in custody without charging you.
If you go the route Benjamin Graham recommended in his famous book, The Intelligent Investor, you can hold your securities in custody with a bank trust department. This gives you fully paid-off assets, in cash, with no chance of an institutional collapse endangering those assets. You should probably pay only a handful of basis points per annum for the service, assuming your account balance is more than six figures.
Special Account Fees
Specialty custodians who agree to deal with nonstandard assets, such as a hedge fund investment held in the form of limited liability company membership units or limited partnership units, often charge higher fees. The same goes for rarer types of self-directed retirement plans, such as a self-directed Roth IRA or self-directed IRA.
These custodial fees can run into the thousands of dollars per year but can be worthwhile for the right investor under the right circumstances. For instance, wealthy investors who want to buy assets such as an entire apartment building under a tax shelter so they pay no tax on the rental income may benefit from specialized services. It would often be impossible for them to use this unique portfolio strategy to produce so much passive income without the help of a specialized custodian.
Custodial Fees and Your Portfolio
Custodial fees and safekeeping fees are one of the things that make up your personal expense ratio, along with any other fees and costs you incur in the management and administration of your investment portfolio. When assessing your expense ratio, it's important to look at the broader picture of your entire portfolio.
Perhaps you're dealing with specialty products and services, with all-inclusive costs on portfolios larger than $1 million that are higher than 1.5%. That focus—all-inclusive costs—is important. Situations exist in which the fees are structured in a way where a firm charging 1.5% is effectively assessing lower fees than a firm purporting to charge only 0.75%, due to the way they treat certain cash and asset classes. You cannot pay attention to the sticker rate alone; you must understand the total assessed fees on your entire portfolio.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.